Chapter 13

LOAN RECEIVABLE

A loan receivable is a financial asset arising from a loan granted by a bank or other financial
institution to a borrower or client.
The term of the loan may be short-term but in most cases, the repayment periods cover several
years.

Initial measurement of loan receivable

At initial recognition, an entity shall measure a loan receivable at fair value plus transaction costs
that are directly attributable to the acquisition of the financial asset.
The fair value of the loan receivable at initial recognition is normally the transaction price,
meaning, the amount of the loan granted.
Transaction costs that are directly attributable to the loan receivable include direct origination
costs.
Direct origination costs should be included in the initial measurement of the loan receivable.
However, indirect origination costs should be treated as outright expense.

Subsequent measurement of loan receivable

If the business model in managing financial asset is to collect contractual cash flows on specified
dates and the contractual cash flows are solely payments of principal and interest, the financial
asset shall be measured at amortized cost.
Meaning of amortized cost
The “amortized cost” is the amount at which the loan receivable is measured initially:
a. Minus principal repayment
b. Plus or minus cumulative amortization of any diffenrence between the initial carrying
amount and the principal maturity amount
c. Minus reduction for impairment or uncollectibility

Origination fees
The fees charged by the back against the borrower for the creation of the loan are known as
“origination fees”.
a. Evaluating the borrower’s financial condition
b. Evaluating guarantees, collateral and other security
 c. Negotiating the terms of the loan
d. Preparing and processing the documents related to the loan
e. Closing and approving the loan transaction

Accounting for origination fees

The origination fees received from borrower are recognized as unearned interest income and
amortized over the term of the loan.
If the origination fees are not chargeable against the borrower, the fees are known as “direct
origination costs”.

Example:
On January 1, 2020 Capontel Bank granted a loan to a borrower. The interest on the loan is 10%
payable annually starting December 31, 2020. On December 31, 2022 in three years the loan will
matures.

January 1, 2008
Loan Receivable 4,000,000
Cash 4,000,000
Cash 342,100
Unearned interest income 341,200
Unearned interest income 150,000
Cash 150,000
December 31, 2018
Cash 400,000
Interest income 400,000
Unearned interest income 56,948
Interest income 56,948
Amortization Table – effective interest method

Interest Interest Amortizatio Carrying

Date Received income n amount
1/1/2020 3,807,900
12/31/202
0 400,000 456,948 56,948 3,864,848
12/31/202
1 400,000 463,782 63,782 3,928,630
12/31/202
2 400,000 471,370 71,370 4,000,000

Formulas

The carrying amount on January 01, 2020 times the effective rate of 12% is equal to interest
income of 456,948Php on december 31, 2020 (3,807,900x.12=456,948) minus interest income of
400,000Php is equal to amortization of 56,948Php (456,948-400,000=56,948) plus the carrying
amount on January 01, 2020 (3,807,900+56,948=3,864,848) is equal to carrying amount of
3,864,848Php on December 31, 2020.

December 31, 2021

Cash 400,000
Interest income 400,000
Unearned interest income 63,782
Interest income 63,782
December 31, 2022
Cash 400,000
Interest income 400,000
Unearned interest income 71,370
Interest income 71,370
Cash 4,000,000
Loan receivable 4,000,000
Problems
1. Nasty Bank granted a loan to a borrower on January 1,2016. The interest on the loan is 10%
payable annually starting December 31, 2016. The loan matures in three years on December 31,
2018.

Principal amount 4,000,000

Direct origination cost incurred 150,000
Origination fee charged against the borrower 342,100

After considering the origination fee charged against the borrower and the direct origination cost
incurred, the effective rate on the loan is 12%.
Required:
1. Prepare journal entries for 2016, 2017 and 2018.

Answer:

Requirement
2016
Jan.1
Loan receivable 4,000,000
Cash 4,000,000
Cash 342,100
Unearned interest income 342,100
Unearned interest income 150,000
Interest income 150,000
Dec.31
Cash 400,000
Interest income 400,000
Unearned interest income 56,948
Interest income 56,948
 Amortization table

Interest Income Carrying

Date Interest Received (10%) Amortization
(12%) Amount
01/01/2016 3,807,900
12/31/2016 400,000 456,948 56,948 3,864,848
12/31/2017 400,000 463,782 63,782 3,928,630
12/31/2018 400,000 471,370 71,370 4,000,000

*12% x 3,928,630 equals 471,435, or a difference of P65 due to rounding.

2017
Dec. 31
Cash 400,000
Interest income 400,000
Unearned interest income 63,782
Interest income 63,782
2018
Dec 31
Cash 400,000
Interest income 400,000
Unearned interest income 71,370
Interest income 71,370

31
Cash 4,000,000
Loan receivable 4,000,000

Impairment of loan
An entity shall recognizea a loss allowance for expected credit losses on financial asset
measured at amortized cost.
 An entity shall measure the loss allowance for a financial instrument at an amount equal to
the lifetime expected credit losses if the credit risk on that financial instrument has increased
significantly since initial recognition.
Credit losses are the present vaue of all cash shortfalls
Expected credit losses are an estimate of credit losses over the life of the financial instrument.

Measurement of impairment
When measuring expected credit losses, an entity should consider:
a. The probability-weighted outcome
The estimate should reflect the possibility that a credit loss occurs and
the possibility the no credit loss occurs.
b. The time value of money
The expected credit losses should be discounted.
c. Reasonable and supportable information that is available without undue cost or effort.

Meaning of credit risk

Credit risk is the risk that one party to a financial instrument will cause a financial loss for the
other party by failing to discharge an obligation.

Example:

Let’s assume that on December 31, 2006, the Lie Dharma Company issued a $1,000,000,
five-year, non-interest-bearing note to the Putra Security Bank, yielding 10% per year. At
the date of the issuance the Lie Dharma Company paid $620,920 = (1,000,000 x 0.62092).
The following entries were made:

1. By the creditor, the Putra Security Bank:

Notes Receivable 1,000,000
Discount on Notes Receivable 379,080
Cash 620,920
2. By the debtor, the Lie Dharma Company
Cash 620,920
Discount on Notes Payable 379,080
Notes 1,000,000
The following table shows the note discount amortization using the effective interest
method:

First Loan Amortization Schedule

Now, let’s assume that because of bad economic conditions for the Lie Dharma Company,
the Putra Security Bank estimates on December 31, 2008, that only $800,000 is collectable at
the end of the five years. Therefore, it estimates its loss due to impairment as follows:

Carrying amount of the loan, 12/31/2008 =751,312.20

Present value of $800,000 due in 3 years at 10% compounded annually (800,000 x 0.75132) =
601,056.00
Loss due to impairment (751,312.20 – 601,056) =150,256.20
Therefore, the Putra Security Bank made the following entry:
Bad Debt Expense 150,256.20
Allowance for Doubtful Accounts 150,256.20

The Lie Dharma Company does not make an entry. The Putra Security Bank prepares a
new schedule of discount amortization based on the new carrying amount of $601,056. It is
shown in the next table:

Second Loan Amortization Schedule

The following entries are made on Dec. 31, 2009:
1. By the Putra Security Bank
Discount on Notes Receivable 75,131.32
Interest Revenue 60,105.60
Allowance for Doubtful Accounts 15,025.72
2. By the Lie Dharma Company
Interest Expense 75,131.32
Discount on Notes Payable 75,131.32
At the maturity date, on January 1, 2000, the Lie Dharma Company pays $800,000 and the
following entries are made:
1. By the Putra Security Bank
Cash 800,000
Allowance for Doubtful Accounts 200,000
Notes Receivable 1,000,000
2. By the Lie Dharma Company
Notes Payable 1,000,000
Cash 800,000
Gain on Extinguishment 200,000

Problems
1. Solvent bank loaned P10,000,000 to a borrower on January 1, 2014. The terms of the loan
require principal payments of P2,000,000 each year for 5 years plus interest at 8%.
The first principal and interest payment is due on december 31, 2014. The borrower made the
required payments on December 31, 2014 and December 31, 2015.
However, during 2016 the borrower began to experience financial difficulties, requiring the bank
to reassess the collectibility of the loan.
On December 31, 2016, the bank has determined that the remaining principal payments will be
collected but the collection of the interest in unlikely. The bank has accrued the interest for 2016.
Expected principal payments
December 31, 2017 1,000,000
December 31, 2018 2,000,000
December 31, 2019 3,000,000

Present value of 1 at 8%
For one period .93
For two periods .86
For three periods .79
Required:
1. Compute the impairment loss on the loan receivable.
2. Prepare journal entries for 2016, 2017 and 2018.
Answer:
Requirement 1
December 31, 2017 (1,000,000 x .93) 900,000
December 31, 2018 (2,000,000 x .86) 1,720,000
December 31, 2019 (3,000,000 x .79) 2,370,000
Total present value of loan 5,020,000

Loan receivable – 12/31/2016 6,000,000

Accrued interest (6,000,000 x 8%) 480,000
Total carrying amount 6,480,000
Present value of loan 5,020,000
Impairment loss 1,460,000

Requirement 2
2016
Impairment loss 1,460,000
Accrued interest receivable 480,000
Allowance for loan impairment 980,000

2017
Cash 1,000,000
Loan receivable 1,000,000

Allowance for loan impairment 401,600

Interest income (8% x 5,020,000) 401,600
2018
Cash 2,000,000
Loan receivable 2,000,000
Allowance for loan impairment 353,728
 Interest income 353,728

Loan receivable – 12/31/2017 5,000,000

Allowance for loan impairment (980,000-401,600) (578,400)
Carrying amount – 12/31/2017 4,421,600

Interest income for 2018 (8% x 4,421,600) 353,728

2019
Cash 3,000,000
Loan receivable 3,000,000
Allowance for loan impairment 224,672
Interest income 224,672

Loan receivable – 12/31/2018 3,000,000

Allowance for loan impairment (578,400 – 353,672) (224,672)
Carrying amount – 12/31/2018 2,775,328

Interest income for 2019 (8% x 2,775,328) 222,026

Allowance per book 224,672
Difference due in rounding 2,646

2. Cozy Bank loaned a borrower P7,500,000 on January 1, 2014. The terms of the loan were
payment in full on January 1, 2019, plus annual interest payment at 12%. The interest payment
was made as scheduled on January 1, 2015. However, due to financial setbacks, the borrower was
unable to make the 2016 interest paymeny.

The bank considered the loan impaired and projected the cash flows from the loan on December
31, 2016.

The bank accrued the interest on December 31, 2015, but did not continue to accrue interest for
2016 due to the impairment of the loan.

Projected cash flows

 Amout projected

Date of cash flow On December 31, 2016

December 31, 2017 5,00,000

December 31, 2018 1,000,000
December 31, 2019 2,000,000
December 31, 2020 4,000,000

Present value of 1 at 12%

For one period .89

For two periods .80
For three periods .71
For four periods .64
Required:

1. Compute the present value of the loan receivable on december 31, 2016
2. Compute the impairment loss on the loan receivable.
3. Prepare journal entries for 2016, 2017 and 2018.

Answer :

Requirement 1

December 31, 2017 (500,000 x .89) 445,000

December 31, 2018 (1,000,000 x .80) 800,000
December 31, 2019 (2,000,000 x .71) 1,420,000
December 31, 2020 (4,000,000 x .64) 2,560,000
Total present value of loan 5,225,000

Requirement 2
Loan receivable 7,500,000
Accrued interest receivable (12% x 7,500,000) 900,000
Total carrying amount 8,400,000

Present value of loan 5,225,000

Impairment loss 3,175,000

Requirement 3

2016

Impairment loss 3,175,000

Accrued interest receivable 900,000

Allowance for loan impairment 2,275,000

2017

Cash 500,000

Loan receivable 500,000

Allowance for loan impairment 627,000

Interest income 627,000

2018

Cash 1,000,000

Loan receivable 1,000,000

Loan receivable – 12/31/2017 7,000,000

Allowance for loan impairment (2,275,000-627,000) (1,648,000)

Carrying amount – 12/31/2017 5,352,000

Interest income for 2018 (12% x 5,352,000) 642,240